Five new stocks made June’s Dividend Growth Stocks Model Portfolio, which was made available to members on June 29, 2023.
Recap from May’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (+7.1%) outperformed the S&P 500 (+5.2%) by 1.9% from May 25, 2023 through June 27, 2023. On a total return basis, the Model Portfolio (+7.4%) outperformed the S&P 500 (+5.6%) by 1.8% over the same time. The best performing stock was up 26%. Overall, 16 out of 29 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from May 25, 2023 through June 27, 2023.
This report leverages our cutting-edge Robo-Analyst technology to deliver proven-superior[1] fundamental research and support more cost-effective fulfillment of the fiduciary duty of care.
This Model Portfolio mimics an “All Cap Blend” style with a focus on dividend growth. Selected stocks earn an Attractive or Very Attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This Model Portfolio is designed for investors who favor long-term capital appreciation over current income, but still appreciate the power of growing dividends.
Featured Stock for June: HP Inc (HPQ: $30/share)
HP Inc. (HPQ) is the featured stock in June’s Dividend Growth Stocks Model Portfolio.
HP has grown revenue by 1% compounded annually and net operating profit after tax (NOPAT) by 4% compounded annually since fiscal 2017. The company’s NOPAT margin increased from 6% in fiscal 2017 to 7% over the trailing twelve months (TTM), and invested capital turns remained unchanged at 1.7 over the same time. Higher NOPAT margins drive return on invested capital (ROIC) from 10% in fiscal 2017 to 12% over the TTM.
Figure 1: HP’s Revenue & NOPAT Since 2017
Sources: New Constructs, LLC and company filings
Free Cash Flow Supports Regular Dividend Payments
HP has increased its regular dividend from $0.56/share in fiscal 2018 to $1.00/share in fiscal 2022, or 16% compounded annually. The current quarterly dividend, when annualized, equals $1.05/share and provides a 3.5% dividend yield.
More importantly, HP’s free cash flow (FCF) easily exceeds its regular dividend payments. From fiscal 2017 through fiscal 2Q23, HP generated $22 billion (54% of current enterprise value) in FCF while paying $6.3 billion in dividends. See Figure 2.
Figure 2: HP’s FCF vs. Regular Dividends Since 2017
Sources: New Constructs, LLC and company filings
Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.
HPQ Is Undervalued
At its current price of $30/share, HP has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects HP’s NOPAT to permanently fall 20% from TTM levels. This expectation seems overly pessimistic given that HP has grown NOPAT by 4% compounded annually since 2017.
Even if HP’s NOPAT margin falls to 6% (ten year low compared to 7% over the TTM) and the company’s revenue grows just 2% compounded annually through 2032, the stock would be worth $40/share today – a 33% upside. See the math behind this reverse DCF scenario. In this scenario, HP’s NOPAT would grow only 2% compounded annually through 2032. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.
Add in HP’s 3.5% dividend yield and a history of dividend growth, and it’s clear why this stock is in June’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we make based on Robo-Analyst findings in HP’s 10-K and 10-Qs:
Income Statement: we made $1.4 billion in adjustments with a net effect of removing $637 million in non-operating expenses (2% of revenue). Clients can see all adjustments made to HP’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $27.5 billion in adjustments to calculate invested capital with a net increase of $21.8 billion. The most notable adjustment was $22.5 billion (181% of reported net assets) in asset write-downs. See all adjustments made to HP’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $11.6 billion in adjustments, with a net decrease in shareholder value of $11.3 billion. One of the most notable adjustments to shareholder value was $11.4 billion in total debt. This adjustment represents 38% of HP’s market value. See all adjustments to HP’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article was originally published on July 5, 2023.
Disclosure: David Trainer, Kyle Guske II, Hakan Salt, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.
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[1] Our research utilizes our Core Earnings, a more reliable measure of profits, as proven in Core Earnings: New Data & Evidence, written by professors at Harvard Business School (HBS) & MIT Sloan and published in The Journal of Financial Economics.